Treasury and the IRS released proposed regulations (REG-136118-15) implementing the new centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (BBA), which replaces the partnership audit rules of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). These proposed regulations are substantially similar to draft proposed regulations that were released publicly by the IRS in January 2017, but were withdrawn before being published in the Federal Register as part of the new Trump administration's initial freeze on regulatory activity.
The BBA is effective for partnerships with tax years beginning after Dec. 31, 2017. In August 2016, the IRS and Treasury issued proposed and temporary regulations on the method by which a partnership could elect into the BBA early. Those regulations are not modified as a result of these new proposed regulations. While some groups have lobbied Congress and Treasury for a delay in the effective date of the new audit rules, it is unclear whether a delay will be enacted or implemented.
The BBA presents a profound shift not only for the partnerships themselves, but also for many C corporations, tax-exempt entities, S corporations and trusts that are partners in partnerships. The rules are designed to shift the burden for actually assessing tax after a partnership-level adjustment from the IRS to the partnership and partners. Partnerships will need to consider changes to their partnership and operating agreements and other transaction documents, like purchase and sale agreements, to respond to the BBA, especially considering the proposed regulations, which tend to place greater import on the relationship between the partners and the partnership representative than between the IRS and the partnership.
In addition, the proposed regulations mention the Tax Technical Corrections Act of 2016, which was introduced but ultimately not enacted by Congress. That legislation would have made both minor and major changes to the BBA, including allowing pass-through partners the ability to make subsequent push-outs to their partners. The proposed regulations lay out "significant administrative concerns" associated with allowing pass-through partners to make a push-out election on the part of the IRS and reserve the issue for future guidance, which is expected in the near future. The IRS also seeks comments on how to administer a system by which a pass-through partner can make a subsequent push-out.
Scope of the centralized audit procedures
The IRS takes a broad approach to the government's ability to make adjustments at the partnership level under the proposed regulations. The statute provides that any adjustment to "items of income, gain, loss, deduction, or credit" of a partnership for a partnership taxable year and any partner's distributive share thereof is determined at the partnership level. The same is true for tax attributable to such items, and the applicability of penalties and additional amounts.
The proposed regulations define the phrase items of income, gain, loss, deduction or credit expansively to mean "all items and information required to be shown, or reflected, on a return of a partnership," which in turn is defined broadly to include, among other things:
Grant Thornton Insight: The broad approach of the scope may cause adjustments related to certain events that would generate a gain or loss at the partner level, e.g., disguised sale of property or a partnership interest by a partner, to be included as an adjustment at the partnership level, to be potentially shared by or burden all of the partners and not just the partner(s) causing the event that triggers the gain or loss.
Character, timing and source of partnership activities Contributions to and distributions from the partnership The partnership's basis in its assets, including the character and type of the assets; the amount and character of partnership liabilities The separate category, timing and amount of the partnership's creditable foreign tax expenditures Elections made by the partnership and the consequences thereof Items related to transactions between the partnership and any person, including disguised sales Items resulting from a partnership termination under Section 708(b)(1)(A), including as a result of a transaction under Rev. Rul. 99-6 Items and effects arising from a technical termination, and partnership capital accounts Penalty defenses
Penalty defenses must be raised by the partnership in a partnership-level proceeding, regardless of whether the defense relates to facts and circumstances relating to a person other than the partnership under the proposed regulations. The proposed regulations give examples of how the penalty defense would apply, requiring the partnership to put forth any argument for reasonable cause. For example, if after the issuance of a notice of proposed partnership adjustment (NOPPA) that imposes an accuracy-related penalty with respect to an imputed underpayment on the grounds that the imputed underpayment is attributable to negligence, the partnership can show that a partner subject to the proceeding had reasonable cause and acted in good faith with respect to how the partner reported those items that were adjusted and gave rise to the underpayment attributable to the penalty. The IRS will take that penalty defense into account when determining the portion of the penalty that relates to the adjustments attributable to the...